ONCE AGAIN: WHY DO WE NEED BOARDS?
Click below to a fascinating research paper by Ulrike Malmendier of Stanford University and Geoffrey Tate of the University of Pennsylvania.
The researchers looked at the personal portfolio decisions of CEOs in Forbes 500 companies. They identified "overconfident" CEOs as those who under diversify their personal portfolios at the expense of maximization of their stock option holdings.
These "overconfident" CEOs tend to engage in more acquisitions than average. They are prone to using cash and untapped debt capacity to create diversification deals.
The empirical results appear that the average merger since the late 1990's destroys value shareholders in the the acquiring firm. But that does not seem to have an impact on the overconfident CEO.
Warren Buffet said it best:
"Many managements apparently were overexposed to the story in which the imprisoned handsome price is released from a toad's body by a kiss from a beautiful princess. They are certain that their managerial kiss will do wonders for the profitability of the target company.
We've observed many kisses but few miracles.
Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses.
THE VALUE OF BOARDS OF DIRECTORS
Put the legal requirements for a Board to one side for a moment. Put Sarbanes Oxley to one side for a moment.
From a business perspective, why do you need competent Boards dominated by strong outsiders?
The argument goes like this:
1. Good CEOs are champions. Champions are bred to have hubris. If they did not have believe in themselves, they would not be aggressive CEOs.
2. In the absence of a strong countervailing force, some CEO Champions will rigidly hold on to a once successful business model that ought to be thrown away. In the absence of a strong countervailing force, some CEO Champions will foolishly rush into M&A activities that defy both logic and statistical probability. In an earlier column, we once wrote about the LBJ Effect: the tendency of leaders to put MORE resources into a failing course of action once the data is clear that it is failing.
3. This strong countervailing force is called the Board of Directors.
What do YOU think?
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